Lenders' issuance of Form 1099-C may not preclude future collection efforts

Federal tax regulations require lenders to provide borrowers with an IRS Form 1099-C, titled Cancellation of Debt, when any one of eight identifiable events occurs in relation to a borrowers’ debt. Borrowers who receive a Form 1099-C generally presume that they are free from any further collection efforts by lenders related to the identified debt. This is because the Form 1099-C generally requires the borrower to recognize discharge of indebtedness of income. While the occurrence of certain identifiable events may cause a debt to be discharged and accordingly bar further collection activities related thereto, courts are split as to whether lenders’ issuance of a Form 1099-C does in itself preclude the ability to continue collection efforts. Thus, under certain circumstances and in certain jurisdictions, lenders may continue collection efforts on a debt identified in a previously issued Form 1099-C. Furthermore, even when issuance of a Form 1099-C does prevent lenders from collecting on the debt identified in the Form, not all hope is lost: lenders may still be able to collect interest expenses, attorneys’ fees and collections costs incurred in relation to the debt identified in the Form 1099-C.

Courts are split on what impact issuing a Form 1099-C has on collecting the identified debt

A majority of courts and the IRS have taken the position that lenders’ issuance of a Form 1099-C does not automatically prohibit further collection activities related to the identified debt. Contrastingly, a minority of courts have taken the position that the issuance of a Form 1099-C does in fact bar a lender from collecting on the identified debt. Many courts that follow the minority view hold that the issuance of a Form 1099-C creates a rebuttable presumption that a debt has been discharged and, therefore, further collections are related to the identified debt are generally precluded.

The most recent Illinois decision to address the issue held that the issuance of a Form 1099-C does not automatically preclude collection efforts, but it does do so if the identifiable event that triggered its issuance constitutes a discharge under Illinois law. However, the court also noted that “it does appears, at least superficially, that whether they are described as discharge or cancellations/extinguishments, all eight of the ‘identifiable events’ foreclose collection” under Illinois law. Thus, it appears that in Illinois, unless a Form 1099-C was issued in error or by mistake, its issuance does automatically preclude collection efforts related to the identified debt.

Interest expenses, collections costs and attorneys’ fees may still be collectible

The IRS regulations do not require a lender’s Form 1099-C to include any amounts other than the principal balance of the debt for which the identifiable event has occurred. As interest, collection costs, and attorneys’ fees related to a debt are not expenses required to be reported on a Form 1099-C, it follows that a debtor who receives a Form 1099-C can still be subjected to a lender’s collection actions related to those expenses. For example, while a court following the minority view did not allow a lender’s collection efforts in a borrower’s bankruptcy with respect to the principal balance of a debt identified in a Form 1099-C, the court allowed the lender to file a claim for the interest expenses, collection costs and attorneys’ fees incurred by lender in relation to the debt before the Form 1099-C was issued. Accordingly, lenders who have previously issued 1099-C forms including these amounts may still be able to seek recovery of certain interest expenses, collection costs and attorneys’ fees related to the identified debt.

Please contact our banking or tax attorneys for additional information to help you with Form 1099-C issues.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client Alert authored by: Eileen M. Sethna, Principal.

Special thanks to Chuhak & Tecson attorney Michael D. Leifman for his contributions to this article.